Equity Returns for Dividend-Paying and Non-Dividend Paying Firms

Abstract

In this paper, we compare the equity returns of dividend-paying and non-dividend paying firms. We find no unconditional return difference even though non-dividend paying firms have many characteristics that suggest high risk. Equivalently, because non-dividend paying firms have high risk-metrics, their returns are abnormally low compared with dividend-paying firms. The reason for these anomalies is that a larger fraction of non-dividend paying firms are in financial distress and, despite high distress-risk and high growth-leverage, firms in financial distress have low returns from high volatility that decreases the options-leverage of equity. Removing firms in financial distress, returns for non-dividend paying firms increase relative to dividend-paying firms and abnormal returns disappear. We argue that part of the reason that firms in financial-distress have high volatility that leads to low returns is managerial risk-shifting that takes form as unexpectedly high capital expenditure rates.